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Tan Liu: Why Many Of Today's Most-Owned Stocks Are Ponzi Schemes

Too much phantom wealth vs cash flow

Former financier and current statistician Tan Liu, author of the recent book The Ponzi Factor: The Simple Truth About Investment Profits [DYI ordered his book at Barnes & Noble cost $8.00] explains how many of today's perpetually dividend-less companies traded on the public market are operating as ponzi schemes by definition. 

As a result, a substantial amount of the market capitalization of our stock market is actually "phantom wealth" that doesn't truly exist. It will vaporize during the next financial crisis as investors proiritize cash flows in-hand over the promises of starry-eyed CEOs:

DYI: Below is the gist of the 49 minute podcast [excellent interview] with the author Tan Liu along with my comments. 

When it comes to stocks, there are two ways of making money. There are capital gains and there are dividends. 

In the case of dividends, there’s nothing wrong with those, because they comes from the profits of the underlying company itself. 

But the issue is with capital gains, the whole buy low/sell high gamble that's promoted 99% of the time on CNBC, financial news networks, and is also the focus of a lot of financial research. 

The issue with capital gains is that they come from other investors. When one investor buys a stock for $100 and then sells it for $110, that extra $10 (or actually the full $110) they’re getting is not coming from the company. It comes from another investor, who will then need to sell it to yet another investor.

DYI: The basic difference between an investor and a speculator is an investor makes money when he buys [interest or dividend stream of payments] as opposed to the speculator when he sells.  Yes it is true under this broad guideline investors have made additional money when they sell.  However as opposed to the speculator they are not held hostage by the whims of other market participants.  

So when one person buys low and sells high, another is also buying high and needs to sell for even higher. And a system where current investors’ profits are dependent on cash from new investors is by definition how a Ponzi scheme works. 

DYI: Completely agree in its essence it is essentially Ponzi like.  Trading profits such as retailer who purchases at whole sale and sells at retail is doing the same thing or an individual trading in art, diamonds, or other objects would be doing the same thing as well.  The biggest take is more along the lines of thinking.  Again those who own non dividend paying companies are completely at the whims of other speculators desire to purchase shares at a higher price.

What’s wrong with that is a lot of stocks don’t pay dividends and why are you an owner of a company if the company never pays the so-called owners? 

How it works because when a stock doesn’t pay dividends, there is no monetary connection between the revenues and profits of the company and the actual shares. 

And the only thing that’s really increasing is just this Ponzi process of one investor trading money with another investor. And it’s fundamentally different from the money itself that investors ultimately want. No one actually wants to buy stocks and say hey. I don’t ever want my money back. I just want stocks and I want to watch that value grow. And I never want my money back. 

Wrong. Everyone wants their money back. Because a stock is essentially completely worthless unless you can get your money back. And every investor that buys stocks wants more money than they contribute.

DYI: The first question a business’ man or women will ask is “How long will it be before I get my money back?”  With a non dividend paying stock that is completely unknown.  With dividend paying companies at least that can be measured with some measure of accuracy.

But if investors are the only ones contributing money into the system, how on earth can they all make money from it? That’s really the bottom line. A stock without dividends is really just a Ponzi asset and there is no monetary connection to the company. 

So therefore, it’s not a real equity instrument at all and furthermore, we can see this because some people say oh, well stocks are real property. How can it be real property if literally companies can print this stuff like toilet paper [stock certificates] at any time they want? Real property takes time to replicate.

DYI: Bingo! Estimations that 15% of publicly traded companies are what are termed as zombies.  The only way they continue their existence is through stock offerings – that dilute existing shareholders – and non stop debt offerings.

 

The debt side of the equation was made possible by the long term downward slide in interest rates since 1981.  If rates have ended their secular decline and start moving back up in earnest these companies will all cease to exist as their modest cash flows will be unable to make their interest payments.  Additional stock offerings will not be enough in that environment.

People forget that the reason why stocks were equity instruments to begin with is that they all pay dividends, according to history. Before the 1900s, all stocks paid dividends and there was a monetary connection between the shareholders and the companies that they owned. 

That’s how stocks were supposed to work. It was supposed to be that simple. You buy a piece of a company; it makes money; you make money. But that’s not how stocks work now. This idea that stocks can literally have no dividends and these companies can make billions and never pay dividends indefinitely. 

Or that these companies can continue losing money and keep printing stocks? In the case of Tesla and many others, this  is a new concept that came out over the past 100 years or so. So the way that stocks work now is fundamentally different from how they actually were designed to work and how they worked before the 1900s.

DYI: It is my understanding that Tesla has lost around 2 billion dollars since their existence.  Through non stop stock and bond offerings all bought up by speculators [many who think of themselves as investors] have been on a wild ride.  So far the irrational love affair with this company remains but Katy bar the door when it ends.  Say bye bye to stock offerings at an ever higher price bringing in millions and debt offerings of billions at cheap interest rates.  When that day arrives it will be a miracle if the company survives.

And a stock without dividends when there is no monetary connection to that company should never be seen as an equity ownership instrument.  

DYI: It is equity in name only but should never be seen in one’s mind as an equity investment.  Companies that are reinvesting all of their earning for faster growth without additional stock offerings or debt placements are minuscule if not outright microscopic in numbers.

Here is an observation made by an unknown author in the comment section at Peak Properity.com was so good I thought I’d share it with you.

As with everything in life, it is important to know who you are dealing with.  "Don't do business with dishonest people."  Amen to that.  In my experience, management is everything.  If they are slimy, then no undervaluation makes it worth your while to put in time and money [if you own large amount of shares]; - you will just end up in court eventually, and that's an utter waste of time and energy. 

On the other hand, fractional ownership is a fine vehicle if management is generally trustworthy.  And that's not about elites or non-elites.  Companies big and small have this same issue. 

Often the "gap" between intrinsic value and price appears because the herd has thundered away from a particular sector for quite some time, and it is deeply unpopular.  I'm sensing that the mining shares could be like that right now [DYI included].  Now I don't know which management is good in the sector, but the people closer in (Sprott, Fleckenstein, etc.) have a much better idea. 

Tradeable gaps occur ultimately because investors are not rational - they are herdlike in nature.  (Of course, sometimes gaps occur because the company is about to die, and the valuation is looking at information that is a year old, and way out of date.  Its important to sort out which one you are dealing with.) 

Now then, am I going to throw out the baby (fractional ownership) with the bathwater (our current state of market disorder and deformation)?  No, I am not.  Although companies do require regulation since, if not kept in check, they can be very predatory.  Kind of like having a big dog around - you need them on a leash at all times. 

Same thing with capitalism [kept on a short leash].  If company market shares are kept small, and money is kept out of politics, and the "commons" are regulated appropriately, then capitalism works great.  Best system ever. That's because it lines up perfectly with the inner nature of humanity.  But let companies grow to take over their marketplace, then they seize government and manipulate things around to keep their cartel control in place, and it’s literally the worst system ever.  This wicked system is exampled by old US Steel of yesteryear; the Seven Sisters of oil or Big Tobacco all of days gone past.  And now: Facebook, Google, Amazon.  Bezo's even acquired his own propaganda vehicle [Washington Post] as yet another lever of control over government. 

Do I throw out capitalism because today's crony-capitalism is horrible?  No.  I prune capitalism back to where it works best.  That's because the other options: socialism, communism, fascism, are just ridiculous - are not even real options, because they do not align well at all with Man's inner nature - the love of a windfall, the desire to minimize work, etc. 

Capitalism worked fairly well when businesses were small, and didn't have enough throw weight to control government.  And you may have noticed my bit about keeping it on a leash - regulation of the commons is important, since capitalism doesn't care about the commons.  That's a tension and a balance, and most definitely capital will always agitate to tip the balance in their favor.  Didn't someone say that the price of liberty is eternal vigilance? 

So yeah.  I'm a fan of capital, capitalism, equity as a funding source, and as an investment.  As long as companies are kept relatively small, it’s the best system ever.  And that's the challenge.  We pruned capital back down to size during the 30's, but people forgot the lessons and let companies get big in the 90's.  The Clinton's got rich, and we got Glass-Stegall repealed, and now we're stuck with cartel-monopoly capitalism. 

And that's the cycle.  We'll eventually prune capital back down again, fix things for another 80 years, and our great-grand-children will dutifully forget the lessons we paid blood to learn and the cycle will begin all over again.

 DYI